European Central Bank set to face down threat of deflation with rate cut as BoE sits tight again

The threat of a damaging deflationary spiral could see the
eurozone’s central bank slash rates into negative territory next week.

On Thursday - the same day that the Bank of England is expected to hold
rates at 0.5 per cent yet again - the European Central Bank is thought likely to
take radical action.

The ECB meeting takes place against the background of a slow
recovery in the 18 countries that share the euro currency. And president Mario Draghi has indicated in recent days that
the bank needed to be on its guard against a crippling ‘negative spiral’ of
falling prices.

In the spotlight: Dramatic moves are expected from the European Central Bank at next week's policy meeting - after Mario Draghi suggested it was minded to do something in June.

Economists think the bank is likely to cut its benchmark
interest rate from 0.25 per cent to stimulate lenders that deposit with it to
provide finance to businesses and consumers.

The ECB could even impose a negative rate, effectively a
charge for holding the money - pushing them to loan money out instead of
hoarding it.

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Other measures might include making more cheap credit
available to banks.

Policymakers could also consider large-scale bond purchases
similar to the quantitative easing schemes employed by the UK and the US - a
policy that the ECB has so far resisted and could prove politically-fraught in
the 18-member zone.

Alternatively it might choose to buy securities based on
loans to small firms as a tool to stimulate businesses' access to finance.

Inflation in the eurozone stands at 0.7 per cent, well below
its target of 2 per cent. Low inflation slows the rate at which household debts and government deficits naturally diminish and deflation, or falling
prices, can stifle growth as consumers put off spending.

Howard Archer, chief UK and European economist at IHS Global
Insight, said the ECB looks poised to produce a package of stimulus measures
after a series of comments building up the prospect.

‘Economic conditions in the eurozone certainly justify
strong action, and If the ECB fails to deliver having built up expectations, it
risks upsetting the markets and also denting its credibility,’ he said.

In the UK, monetary policy committee members face a
different challenge of deciding when they must raise interest rates, which have
been at 0.5 per cent for five years, to prevent the economy overheating.

In the spotlight: Dramatic moves are expected from the European Central Bank at next week's policy meeting - after Mario Draghi suggested it was minded to do something in June.

Some analysts have brought forward expectations that this
will happen in spring next year, in the wake of sharp growth and the steep fall
in unemployment. Minutes of the last MPC meeting suggested some members were
moving closer towards voting for a rise.

Martin Weale, one member of this camp, told the Financial
Times that rates must start to rise sooner if the Bank wants to stick to its
plan to hike them only at a gradual pace of‘baby steps’.

But he also indicated he would not be voting for an increase
immediately, telling the FT:‘We can
wait a bit longer... The best judgment I can have is that it's not so urgent it
needs doing now.’

Jonathan Loynes, chief European economist at Capital
Economics, said:‘While the MPC will
leave policy on hold again... it is clear that some members are getting closer
to voting for higher interest rates.’

But he added that provided inflation remains low and that
the Bank uses separate tools to take any action needed to cool the housing
market, rates ‘could remain at their current levels until well into next year’.

Official figures this week showed the US economy slammed into reverse at the start of the year, when unusually harsh winter weather disrupted business.

Gross domestic product fell at an annual rate of 1 per cent in the first three months of 2014 – worse than the growth of 0.1 per cent initially reported and down from 2.6 per cent growth at the end of 2013. It was the first decline since the start of 2011 and the equivalent of a 0.25 per cent fall on a quarterly basis.

By contrast, the UK economy grew by 0.8 per cent during the same period. Figures from the Confederation of British Industry yesterday suggested Britain's economy has seen its best month of growth for over ten years.

More positive signs come from two further reports released today, which suggest confidence is on the rise and that the UK economy could be heading for its best year since the financial crisis.

The British Chambers of Commerce is now expecting growth of 3.1 per cent this year – the strongest rate of expansion since 2007.